No country is safe from emerging market meltdown
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Battle-weary policy makers do not want to believe that an emerging market crisis is possible. But there are striking resemblances now to the economic troubles these countries suffered in the 1990s.
Then, loose monetary policies pursued by the Federal Reserve and the Bank of Japan brought large capital inflows into emerging markets, especially Asia. In 1994, Federal Reserve Chairman Alan Greenspan withdrew liquidity, resulting in a doubling of U.S. interest rates over 12 months.
In the 1994 ‘Great Bond Massacre’, holders of Treasury bonds suffered losses of around $600 billion. Trading losses led to the bankruptcy of Orange County in California, the effective closure of Kidder Peabody and failures of many investment funds.
The Fed’s move triggered a crisis in Mexico and across Latin America. It precipitated the Asian monetary crisis, requiring International Monetary Fund bailouts for Indonesia, South Korea and Thailand. Asia took more than a decade to recover from the economic losses.
Repeat underperformance
There’s reason now to fear a rerun of this economic collapse in the emerging markets, triggered by rapid capital outflows and a rising U.S. dollar.
The basic trajectory is familiar: Weaknesses in the real economy and financial vulnerabilities rapidly feed each other in a vicious cycle. Even if the reduction of excessive monetary accommodation in developed economies is slow or deferred, the fundamental frailties of emerging markets — current account deficits, inadequate investment returns and high debt levels — will prove problematic.
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